FORM 10-Q. NATIONAL WESTERN LIFE INSURANCE COMPANY (Exact name of Registrant as specified in its charter)

Transcription

1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C FORM 10-Q [ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2005 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: NATIONAL WESTERN LIFE INSURANCE COMPANY (Exact name of Registrant as specified in its charter) COLORADO (State of Incorporation) (I.R.S. Employer Identification Number) 850 EAST ANDERSON LANE AUSTIN, TEXAS (512) (Address of Principal Executive Offices) (Telephone Number) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [ ] No [ ] Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ ] As of August 2, 2005, the number of shares of Registrants common stock outstanding was: Class A - 3,409,814 and Class B - 200,000.

2 INDEX Part I. Financial Information: Page Item 1. Financial Statements 3 Condensed Consolidated Balance Sheets June 30, 2005 (Unaudited) and December 31, Condensed Consolidated Statements of Earnings For the Three Months Ended June 30, 2005 and 2004 (Unaudited) 5 Condensed Consolidated Statements of Earnings For the Six Months Ended June 30, 2005 and 2004 (Unaudited) 6 Condensed Consolidated Statements of Comprehensive Income For the Three Months Ended June 30, 2005 and 2004 (Unaudited) 7 Condensed Consolidated Statements of Comprehensive Income For the Six Months Ended June 30, 2005 and 2004 (Unaudited) 8 Condensed Consolidated Statements of Stockholders' Equity For the Six Months Ended June 30, 2005 and 2004 (Unaudited) 9 Condensed Consolidated Statements of Cash Flows For the Six Months Ended June 30, 2005 and 2004 (Unaudited) 10 Notes to Condensed Consolidated Financial Statements (Unaudited) 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 21 Item 3. Quantitative and Qualitative Disclosures About Market Risk 44 Item 4. Controls and Procedures 44 Part II. Other Information: Item 1. Legal Proceedings 45 Item 4. Submission of Matters to a Vote of Security Holders 45 Item 6. Exhibits and Reports on Form 8-K 45 Signatures 46 2

3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) June 30, December 31, ASSETS Investments: Securities held to maturity, at amortized cost $ 3,392,075 3,274,134 Securities available for sale, at fair value 1,704,401 1,635,247 Mortgage loans, net of allowances for possible losses ($0 and $368) 116, ,712 Policy loans 86,877 88,448 Derivatives 35,873 42,156 Other long-term investments 35,136 45,702 Total investments 5,371,109 5,210,399 Cash and short-term investments 81,451 50,194 Deferred policy acquisition costs 592, ,218 Deferred sales inducements 69,160 62,240 Accrued investment income 60,237 58,272 Other assets 39,729 28,362 $ 6,214,457 5,991,685 Note: The condensed consolidated balance sheet at December 31, 2004, has been derived from the audited consolidated financial statements as of that date. See accompanying notes to condensed consolidated financial statements. 3

4 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) (Unaudited) June 30, December 31, LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Future policy benefits: Traditional life and annuity contracts $ 139, ,049 Universal life and annuity contracts 5,041,709 4,885,809 Other policyholder liabilities 87,538 75,237 Federal income tax liability: Current 1,776 4,303 Deferred 45,312 38,754 Other liabilities 46,044 37,861 Total liabilities 5,362,066 5,183,013 COMMITMENTS AND CONTINGENCIES (Notes 5 and 7) STOCKHOLDERS' EQUITY: Common stock: Class A - $1 par value; 7,500,000 shares authorized; 3,404,925 and 3,384,215 issued and outstanding in 2005 and ,405 3,384 Class B - $1 par value; 200,000 shares authorized, issued, and outstanding in 2005 and Additional paid-in capital 36,297 33,834 Accumulated other comprehensive income 26,354 25,419 Retained earnings 786, ,835 Total stockholders' equity 852, ,672 $ 6,214,457 5,991,685 Note: The condensed consolidated balance sheet at December 31, 2004, has been derived from the audited consolidated financial statements as of that date. See accompanying notes to condensed consolidated financial statements. 4

5 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS For the Three Months Ended June 30, 2005 and 2004 (Unaudited) (In thousands, except per share amounts) Premiums and other revenue: Traditional life and annuity premiums $ 3,932 3,633 Universal life and annuity contract revenues 24,642 22,882 Net investment income 79,488 76,475 Other income 2,319 2,476 Realized gains on investments 7,616 2,013 Total premiums and other revenue 117, ,479 Benefits and expenses: Life and other policy benefits 9,432 7,505 Amortization of deferred policy acquisition costs 22,325 24,071 Universal life and annuity contract interest 39,172 42,824 Other operating expenses 11,098 3,766 Total benefits and expenses 82,027 78,166 Earnings before Federal income taxes 35,970 29,313 Provision for Federal income taxes: Current 11,592 8,995 Deferred Total Federal income taxes 11,872 9,601 Net earnings $ 24,098 19,712 Basic Earnings Per Share $ Diluted Earnings Per Share $ See accompanying notes to condensed consolidated financial statements. 5

6 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS For the Six Months Ended June 30, 2005 and 2004 (Unaudited) (In thousands, except per share amounts) Premiums and other revenue: Traditional life and annuity premiums $ 7,413 7,021 Universal life and annuity contract revenues 48,590 43,887 Net investment income 142, ,956 Other income 4,552 4,607 Realized gains on investments 8,584 3,472 Total premiums and other revenue 211, ,943 Benefits and expenses: Life and other policy benefits 20,660 16,909 Amortization of deferred policy acquisition costs 41,399 44,791 Universal life and annuity contract interest 66,527 80,503 Other operating expenses 22,141 14,201 Total benefits and expenses 150, ,404 Earnings before Federal income taxes and cumulative effect of change in accounting principle 60,646 51,539 Provision for Federal income taxes: Current 17,884 11,773 Deferred 2,462 5,438 Total Federal income taxes 20,346 17,211 Earnings before cumulative effect of change in accounting principle 40,300 34,328 Cumulative effect of change in accounting principle, net of $29,452 of Federal income taxes - 54,697 Net earnings $ 40,300 89,025 Basic Earnings Per Share: Earnings before cumulative effect of change in accounting principle $ Cumulative effect of change in accounting principle Net earnings $ Diluted Earnings Per Share: Earnings before cumulative effect of change in accounting principle $ Cumulative effect of change in accounting principle Net earnings $ See accompanying notes to condensed consolidated financial statements. 6

7 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Three Months Ended June 30, 2005 and 2004 (Unaudited) Net earnings $ 24,098 19,712 Other comprehensive income (loss) net of effects of deferred policy acquisition costs and taxes: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period 11,124 (17,694) Reclassification adjustment for gains included in net earnings (276) (735) Amortization of net unrealized losses (gains) related to transferred securities (15) 168 Net unrealized gains (losses) on securities 10,833 (18,261) Foreign currency translation adjustments 16 (79) Other comprehensive income (loss) 10,849 (18,340) Comprehensive income $ 34,947 1,372 See accompanying notes to condensed consolidated financial statements. 7

8 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Six Months Ended June 30, 2005 and 2004 (Unaudited) Net earnings $ 40,300 89,025 Other comprehensive income (loss), net of effects of deferred policy acquisition costs and taxes: Net unrealized gains (losses) on securities: Net unrealized holding gains (losses) arising during period 1,401 (10,727) Reclassification adjustment for gains included in net earnings (639) (682) Amortization of net unrealized losses (gains) related to transferred securities (12) 230 Net unrealized gains (losses) on securities 750 (11,179) Foreign currency translation adjustments 185 (145) Other comprehensive income (loss) 935 (11,324) Comprehensive income $ 41,235 77,701 See accompanying notes to condensed consolidated financial statements. 8

9 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Six Months Ended June 30, 2005 and 2004 (Unaudited) Common stock: Balance at beginning of year $ 3,584 3,547 Shares exercised under stock option plan Balance at end of period 3,605 3,563 Additional paid-in capital: Balance at beginning of year 33,834 29,192 Shares exercised under stock option plan, net of tax benefits 1,954 1,594 Stock option expense Balance at end of period 36,297 31,097 Accumulated other comprehensive income: Unrealized gains on securities: Balance at beginning of year 25,032 22,467 Change in unrealized gains (losses) during period 750 (11,179) Balance at end of period 25,782 11,288 Foreign currency translation adjustments: Balance at beginning of year 3,170 3,297 Change in translation adjustments during period 185 (145) Balance at end of period 3,355 3,152 Minimum pension liability adjustment: Balance at beginning of year (2,783) (2,311) Change in minimum pension liability adjustment during period - - Balance at end of period (2,783) (2,311) Accumulated other comprehensive income at end of period 26,354 12,129 Retained earnings: Balance at beginning of year 745, ,666 Net earnings 40,300 89,025 Balance at end of period 786, ,691 Total stockholders' equity $ 852, ,480 See accompanying notes to condensed consolidated financial statements. 9

10 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 2005 and 2004 (Unaudited) Cash flows from operating activities: Net earnings $ 40,300 89,025 Adjustments to reconcile net earnings to net cash from operating activities: Universal life and annuity contract interest 66,527 80,503 Surrender charges and other policy revenues (14,579) (12,680) Realized gains on investments (8,584) (3,472) Accrual and amortization of investment income (1,791) (4,314) Depreciation and amortization Decrease in value of derivatives 9,278 14,460 Increase in deferred policy acquisition and sale inducement costs (11,076) (37,023) Increase in accrued investment income (1,966) (2,883) Decrease (increase) in other assets (10,106) 1,303 Decrease in liabilities for future policy benefits (1,362) (1,069) Increase in other policyholder liabilities 12,301 1,682 Increase in Federal income tax liability ,707 Decrease in other liabilities (1,884) (11,437) Decrease in accrued lawsuit settlement - (9,700) Cumulative effect of change in accounting principle, before taxes - (84,149) Other (1,141) (225) Net cash provided by operating activities 77,719 47,560 Cash flows from investing activities: Proceeds from sales of: Securities held to maturity 10,853 8,749 Securities available for sale 11,890 18,866 Other investments 31,018 14,099 Proceeds from maturities and redemptions of: Securities held to maturity 170, ,491 Securities available for sale 62,670 41,675 Purchases of: Securities held to maturity (297,587) (484,664) Securities available for sale (138,651) (171,366) Other investments (17,360) (14,966) Principal payments on mortgage loans 14,021 21,299 Cost of mortgage loans acquired (5,617) (7,594) Decrease in policy loans 1,572 1,493 Other (1,006) (512) Net cash used in investing activities (157,613) (383,430) (Continued on next page) 10

11 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED For the Six Months Ended June 30, 2005 and 2004 (Unaudited) Cash flows from financing activities: Deposits to account balances for universal life and annuity contracts $ 328, ,048 Return of account balances on universal life and annuity contracts (219,059) (220,289) Issuance of common stock under stock option plan 1,317 1,165 Net cash provided by financing activities 111, ,924 Effect of foreign exchange (17) 44 Net increase (decrease) in cash and cash equivalents 31,257 (7,902) Cash and cash equivalents at beginning of year 50,194 68,210 Cash and cash equivalents at end of period $ 81,451 60,308 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the six month period for: Interest $ Income taxes 17,100 19,700 See accompanying notes to condensed consolidated financial statements. 11

12 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) CONSOLIDATION AND BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for annual financial statements. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of June 30, 2005, and the results of its operations and its cash flows for the three months and six months ended June 30, 2005 and The results of operations for the three months and six months ended June 30, 2005 and 2004 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2004 accessible free of charge through the Company's internet site at or the Securities and Exchange Commission internet site at The accompanying condensed consolidated financial statements include the accounts of National Western Life Insurance Company and its wholly owned subsidiaries ("Company"), The Westcap Corporation, NWL Investments, Inc., NWL Services, Inc., and NWL Financial, Inc. All significant intercorporate transactions and accounts have been eliminated in consolidation. Certain reclassifications have been made to the prior periods to conform to the reporting categories used in (2) CHANGES IN ACCOUNTING PRINCIPLES In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"). SOP 03-1 provides guidance relating to the reporting by insurance enterprises for certain contracts and insurance specific accounting issues and is effective for financial statements for fiscal years beginning after December 15, In the first quarter of 2004, the Company adopted the reserving method for its two-tier annuity products, which were issued from 1984 until 1992, in accordance with the SOP 03-1 guidance. The new reserving method under SOP 03-1 requires that the Company hold a reserve equal to the cash surrender value and establish an additional liability for expected annuitizations. The Company previously maintained reserves for two-tier annuities at the account balance value which is substantially higher than the cash value reserve. This reserving change resulted in an adjustment decreasing reserves, less deferred acquisition costs written off, by $54.7 million, net of taxes. The amount is reflected as a change in accounting principle as of January 1, Components of the accounting change are detailed below. Accounting change related to two-tier annuities: Amounts Reduction in reserve for future policy benefits $ 119,205 Write off of deferred acquisition costs (35,056) Total change, pre-tax 84,149 Federal income taxes (29,452) Cumulative effect of change in accounting for two-tier annuities, net of tax $ 54,697 At June 30, 2005, the Company held a reserve relating to two-tier annuities in the amount of $20.4 million as an additional liability relating to annuitization benefits. The expected annuitizations were determined based upon actual experience relating to this block of business, which is relatively seasoned and the policies are no longer issued by the Company. The issuance of this SOP did not impact the Company's accounting relating to sales inducements. 12

13 In March 2004, the Emerging Issues Task Force ("EITF") reached a final consensus on Issue 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. This Issue establishes impairment models for determining whether to record impairment losses associated with investments in certain equity and debt securities and requires expanded disclosures related to securities with unrealized losses. It also requires income to be accrued on a level-yield basis following an impairment of debt securities, where reasonable estimates of the timing and amount of future cash flows can be made. The Company's current policy has generally been to record income only as cash is received following an impairment of a debt security. The application of this Issue was required for reporting periods beginning after June 15, In September 2004, the Financial Accounting Standard Board ("FASB") approved FASB Staff Position EITF , which defers the effective date for the recognition and measurement guidance contained in EITF 03-1 until certain issues are resolved. The Company is not able to assess the impact of the adoption of EITF 03-1 until final guidance is issued. The Company has adopted the disclosure provisions which are currently in effect. In December 2004, the FASB issued Statement No. 123(R), Share-Based Payment ("FAS 123(R)") which is a revision of Statement No Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The Company currently uses the Black-Scholes-Merton option pricing model to estimate the value of employee stock options and expects to continue to use this acceptable option pricing model upon adoption of Statement No. 123(R). Statement No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow rather than as an operating cash flow, as currently required. The original effective date set by the FASB was to begin with the first fiscal quarter after June 15, The Securities and Exchange Commission announced on April, 14, 2005 a six month postponement of FAS 123(R) which requires companies to apply the accounting standard beginning with the first fiscal year after June 15, The adoption of Statement No. 123(R) is not expected to have a material impact on the consolidated financial statements of the Company. Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on the Company's present or future consolidated financial statements. (3) STOCKHOLDERS' EQUITY The Company is restricted by state insurance laws as to dividend amounts which may be paid to stockholders without prior approval from the Colorado Division of Insurance. The Company paid no cash dividends on common stock during the six months ended June 30, 2005 and 2004, as it follows a policy of retaining earnings in order to finance the development of business and to meet regulatory requirements for capital. (4) EARNINGS PER SHARE Basic earnings per share of common stock are computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted earnings per share assumes the issuance of common shares applicable to stock options. Refer to Exhibit 11 of this report for further information concerning the computation of earnings per share. 13

14 (5) PENSION AND OTHER POSTRETIREMENT PLANS (A) Defined Benefit Pension Plans The Company sponsors a qualified defined benefit pension plan covering substantially all full-time employees. The plan provides benefits based on the participants' years of service and compensation. The Company makes annual contributions to the plan that comply with the minimum funding provisions of the Employee Retirement Income Security Act of 1974 ("ERISA"). The following summarizes the components of net periodic benefit costs. Three Months Ended June 30, Six Months Ended June 30, Service cost $ Interest cost Expected return on plan assets (246) (245) (455) (417) Amortization of prior service cost Amortization of net loss Net periodic benefit cost $ As previously disclosed in its financial statements for the year ended December 31, 2004, the Company expects to contribute $1.6 million to the plan in Contributions of $0.4 million have been made through June 30, The Company also sponsors a nonqualified defined benefit plan primarily for senior officers. The plan provides benefits based on the participants' years of service and compensation. The pension obligations and administrative responsibilities of the plan are maintained by a pension administration firm, which is a subsidiary of American National Insurance Company ("ANICO"). ANICO has guaranteed the payment of pension obligations under the plan. However, the Company has a contingent liability with respect to the pension plan should these entities be unable to meet their obligations under the existing agreements. Also, the Company has a contingent liability with respect to the plan in the event that a plan participant continues employment with the Company beyond age seventy, the aggregate average annual participant salary increases exceed 10% per year, or any additional employees become eligible to participate in the plan. If any of these conditions are met, the Company would be responsible for any additional pension obligations resulting from these items. Amendments were made to the plan to allow an additional employee to participate and to change the benefit formula for the Chairman of the Company. Any additional obligations are a liability to the Company. The following summarizes the components of net periodic benefit costs. Three Months Ended June 30, Six Months Ended June 30, Service cost $ Interest cost Amortization of prior service cost Amortization of net loss Net periodic benefit cost $ As previously disclosed in its financial statements for the year ended December 31, 2004, the Company expects to contribute $0.3 million to the plan in No contributions have been made as of June 30,

15 (B) Defined Benefit Postretirement Plans The Company sponsors two health care plans that were amended in 2004 to provide postretirement benefits to certain fully-vested individuals. The following summarizes the components of net periodic benefit cost. Three Months Six Months Ended Ended June 30, 2005 June 30, 2005 Interest cost $ Amortization of prior service cost Net periodic benefit cost $ As previously disclosed in its financial statements for the year ended December 31, 2004, the Company expects to contribute minimal amounts to the plan in

16 (6) SEGMENT AND OTHER OPERATING INFORMATION Under Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosures About Segments of an Enterprise and Related Information, the Company defines its reportable operating segments as domestic life insurance, international life insurance, and annuities. These segments are organized based on product types and geographic marketing areas. A summary of segment information for the quarters ended June 30, 2005 and 2004 is provided below. Selected Segment Information. Domestic International Life Life All Insurance Insurance Annuities Others Totals June 30, 2005: Selected Balance Sheet Items: Deferred policy acquisition costs and sales inducements $ 46, , , ,931 Total segment assets 369, ,811 5,136,518 93,325 6,194,153 Future policy benefits 304, ,106 4,455,778-5,181,396 Other policyholder liabilities 10,348 11,484 65,706-87,538 Three Months Ended June 30, 2005: Condensed Income Statements: Premiums and contract revenues $ 6,035 17,305 5,234-28,574 Net investment income 4,849 5,752 64,487 4,400 79,488 Other income ,198 2,319 Total revenues 10,892 23,075 69,816 6, ,381 Life and other policy benefits 3,610 5, ,432 Amortization of deferred policy acquisition costs 614 5,931 15,780-22,325 Universal life and annuity contract interest 2,188 4,971 32,013-39,172 Other operating expenses 2,099 2,772 4,313 1,914 11,098 Federal income taxes 785 1,397 5,475 1,550 9,207 Total expenses 9,296 20,139 58,335 3,464 91,234 Segment earnings $ 1,596 2,936 11,481 3,134 19,147 16

17 Domestic International Life Life All Insurance Insurance Annuities Others Totals Six Months Ended June 30, 2005: Condensed Income Statements: Premiums and contract revenues $ 12,116 34,342 9,545-56,003 Net investment income 9,827 11, ,158 5, ,234 Other income ,322 4,552 Total revenues 21,959 45, ,885 9, ,789 Life and other policy benefits 8,270 11,051 1,339-20,660 Amortization of deferred policy acquisition costs 1,832 10,845 28,722-41,399 Universal life and annuity contract interest 4,369 8,583 53,575-66,527 Other operating expenses 4,299 6,101 7,950 3,791 22,141 Federal income taxes 1,062 2,959 11,425 1,896 17,342 Total expenses 19,832 39, ,011 5, ,069 Segment earnings $ 2,127 5,925 22,874 3,794 34,720 17

18 Selected Segment Information. Domestic International Life Life All Insurance Insurance Annuities Others Totals June 30, 2004 Selected Balance Sheet Items: Deferred policy acquisition costs and sales inducements $ 50, , , ,216 Total segment assets 360, ,828 4,672,088 78,404 5,652,939 Future policy benefits 299, ,858 4,082,680-4,768,493 Other policyholder liabilities 9,992 11,107 43,082-64,181 Three Months Ended June 30, 2004: Condensed Income Statements: Premiums and contract revenues $ 5,635 16,174 4,706-26,515 Net investment income 4,982 5,316 63,645 2,532 76,475 Other income ,071 2,476 Total revenues 10,619 21,490 68,754 4, ,466 Life and other policy benefits 2,601 3, ,505 Amortization of deferred policy acquisition costs 1,934 6,126 16,011-24,071 Universal life and annuity contract interest 2,073 4,666 36,085-42,824 Other operating expenses 1,998 2,816 (2,780) 1,732 3,766 Federal income taxes 668 1,263 6, ,897 Total expenses 9,274 18,857 56,253 2,679 87,063 Segment earnings $ 1,345 2,633 12,501 1,924 18,403 18

19 Domestic International Life Life All Insurance Insurance Annuities Others Totals Six Months Ended June 30, 2004: Condensed Income Statements: Premiums and contract revenues $ 11,208 32,299 7,401-50,908 Net investment income 10,009 10, ,811 3, ,956 Other income ,144 4,607 Total revenues 21,222 43, ,670 7, ,471 Life and other policy benefits 6,724 8,772 1,413-16,909 Amortization of deferred policy acquisition costs 3,189 12,502 29,100-44,791 Universal life and annuity contract interest 4,289 9,095 67,119-80,503 Other operating expenses 4,262 5, ,512 14,201 Federal income taxes 918 2,331 11,479 1,268 15,996 Total expenses 19,382 38, ,657 4, ,400 Segment earnings $ 1,840 4,675 23,013 2,543 32,071 Reconciliations of segment information to the Company's condensed consolidated financial statements are provided below. Three Months Ended June 30, Six Months Ended June 30, Premiums and Other Revenue: Premiums and contract revenues $ 28,574 26,515 56,003 50,908 Net investment income 79,488 76, , ,956 Other income 2,319 2,476 4,552 4,607 Realized gains on investments 7,616 2,013 8,584 3,472 Total consolidated premiums and other revenue $ 117, , , ,943 19

20 Three Months Ended June 30, Six Months Ended June 30, Federal Income Taxes: Total segment Federal income taxes $ 9,207 8,897 17,342 15,996 Taxes on realized gains on investments 2, ,004 1,215 Taxes on cumulative effect of change in accounting principle ,452 Total consolidated Federal income taxes $ 11,872 9,601 20,346 46,663 Three Months Ended June 30, Six Months Ended June 30, Net Earnings: Total segment earnings $ 19,147 18,403 34,720 32,071 Realized gains on investments, net of taxes 4,951 1,309 5,580 2,257 Cumulative effect of change in accounting principle ,697 Total consolidated net earnings $ 24,098 19,712 40,300 89,025 June 30, Assets: Total segment assets $ 6,194,153 5,652,939 Other unallocated assets 20,304 18,540 Total consolidated assets $ 6,214,457 5,671,479 (7) LEGAL PROCEEDINGS In the course of an audit of a charitable tax-exempt foundation, the Internal Revenue Service ("IRS") raised an issue under the special provisions of the Internal Revenue Code ("IRC") governing tax-exempt private foundations as to certain interest-bearing loans from the Company to another corporation in which the tax-exempt foundation owns stock. The issue is whether such transactions constitute indirect self-dealing by the foundation, the result of which would be excise taxes on the Company by virtue of its participation in such transactions. By letter to the Company dated August 21, 2003, the IRS proposed an initial excise tax liability in the total amount approximating one million dollars as a result of such transactions. The Company disagrees with the IRS analysis. The Company is contesting the matter and expects to prevail on the merits. On October 14, 2003, in response to the IRS letter, the Company requested that this issue instead be referred to the IRS National Office for technical advice. The IRS audit team agreed and the matter was referred in November of 2003 to the IRS National Office. Such technical advice when issued by the IRS National Office will be in the form of a memorandum analyzing the issue which will be binding on the IRS audit team. The Company is involved or may become involved in various legal actions, in the normal course of business, in which claims for alleged economic and punitive damages have been or may be asserted, some for substantial amounts. Although there can be no assurances, at the present time, the Company does not anticipate that the ultimate liability arising from potential, pending, or threatened legal actions, after consideration of amounts provided for in the Company's consolidated financial statements, will have a material adverse effect on the financial condition or operating results of the Company. 20

21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information contained herein or in other written or oral statements made by or on behalf of National Western Life Insurance Company or its subsidiaries is or may be viewed as forward-looking. Although the Company has used appropriate care in developing any such information, forward-looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, matters described in the Company's filings with the Securities and Exchange Commission ("SEC") such as exposure to market risks, anticipated cash flows or operating performance, future capital needs, and statutory or regulatory related issues. However, National Western, as a matter of policy, does not make any specific projections as to future earnings, nor does it endorse any projections regarding future performance that may be made by others. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments. Also, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise. OVERVIEW Insurance Operations - Domestic The Company is currently licensed to do business in all states except for New York. Products marketed are annuities, universal life insurance, equity-indexed universal life insurance and traditional life insurance, which include both term and whole life products. The majority of domestic sales are the Company's annuities, which include single and flexible premium deferred annuities, single premium immediate annuities, and equity-indexed annuities. Most of these annuities can be sold as tax qualified or nonqualified products. At June 30, 2005, the Company maintained approximately 123,300 annuity policies in force. National Western markets and distributes its domestic products primarily through independent national marketing organizations ("NMOs"). These NMOs assist the Company in recruiting, contracting, and managing independent agents. The Company currently has approximately 10,700 independent agents contracted. Roughly 22% of these contracted agents have submitted policy applications to the Company in the past twelve months. Insurance Operations - International The Company's international operations focus on foreign nationals in upper socioeconomic classes. Insurance products are issued primarily to residents of countries in Central and South America, the Caribbean, Eastern Europe and the Pacific Rim. Issuing policies to residents of countries in these different regions provides diversification that helps to minimize large fluctuations that could arise due to various economic, political, and competitive pressures that may occur from one country to another. Products issued to international residents are almost entirely universal life and traditional life insurance products. However, certain investment contracts are also available. At June 30, 2005, the Company had approximately 63,700 international life insurance policies in force representing approximately $11.6 billion in face amount of coverage. International applications are submitted by independent contractor broker-agents. The Company has approximately 3,800 independent international brokers currently contracted, over 45% of which have submitted policy applications to the Company in the past twelve months. There are some inherent risks of accepting international applications which are not present within the domestic market that are reduced substantially by the Company in several ways. As previously described, the Company accepts applications from foreign nationals in upper socio-economic classes who have substantial financial resources. This targeted customer base coupled with National Western's conservative underwriting practices have historically resulted in claims experience, due to natural causes, similar to that in the United States. The Company minimizes exposure to foreign currency risks by requiring payment of premiums, claims, and other benefits almost entirely in United States dollars. Finally, the Company's nearly forty years of experience with the international products and its longstanding independent broker-agents relationships further serve to minimize risks. 21

22 SALES Life Insurance The following table sets forth information regarding the Company's life insurance sales activity as measured by annualized first year premiums. While the figures shown below are in accordance with industry practice and represent the amount of new business sold during the periods indicated, they are considered a non-gaap financial measure. The Company believes sales are a measure of distribution productivity and are a leading indicator of future revenue trends. However, revenues are driven by sales in prior periods as well as in the current period and therefore, a reconciliation of sales to revenues is not meaningful or determinable. Three Months Ended June 30, Six Months Ended June 30, International: Universal life $ 1,286 2,080 2,548 4,068 Traditional life ,671 1,077 Equity-indexed life 4,416 4,190 8,038 7,987 6,625 6,848 12,257 13,132 Domestic: Universal life , Traditional life ,623 1,146 Totals $ 7,406 7,514 13,880 14,278 Total life insurance sales as measured by annualized first year premiums decreased 1% in the second quarter of 2005 as compared to the second quarter of 2004 and were down 3% in the first six months of 2005 as compared to The slight declines in life insurance sales pertain to the Company s international life business where applications from residents outside of the United States typically vary based upon changes in the socio-economic climates of these countries. Historically, the Company has experienced a simultaneous combination of rising and declining sales in various countries; however, the appeal of the Company s dollar-denominated life insurance products overcomes many of the local and national difficulties. Applications submitted from residents of South America and the Pacific Rim perennially have comprised the majority of the Company s international life insurance sales. Over the past few years, effort has been directed toward the sale of a traditional endowment form of life insurance product for residents of Eastern European countries. While business is still in a developmental phase, sales from these countries comprised over 4% of total international life insurance sales in the first six months of the year. Year-to-date, the Company has recorded sales to residents outside of the United States in over thirty different countries with Brazil (35%), Venezuela (11%), and Taiwan (10%) making up the largest markets. Domestic operations have generally focused more heavily on annuity sales than on life insurance sales. The Company spent the greater part of 2003 and 2004 revamping its domestic life operations by changing the way it contracts distribution for life business, eliminating products and distribution that have not contributed significantly to earnings, and creating new and competitive products. A new single premium universal life ("SPUL") product was launched at the end of 2003 accounting for the majority of the increase in domestic universal life insurance sales thus far in With the introduction of the SPUL product and the discontinued marketing of smaller premium and volume life insurance policies, the Company has seen an increase in the average amount of per policy coverage purchased from $97,000 in 2004 to $108,000 in 2005 year-to-date. The Company is currently developing an equity-indexed universal life product for its domestic markets and anticipates incremental sales activity associated with this product to begin toward the end of the third calendar quarter of

23 The following table sets forth information regarding the Company's life insurance in force for each date presented. Insurance In Force as of June 30, ($ in thousands) Universal life: Number of policies 81,400 85,510 Face amounts $ 8,165,030 8,511,030 Traditional life: Number of policies 56,140 58,420 Face amounts $ 1,695,510 1,570,830 Equity-indexed life: Number of policies 13,320 9,080 Face amounts $ 2,691,930 1,798,540 Rider face amounts $ 1,486,620 1,370,390 Total life insurance: Number of policies 150, ,010 Face amounts $ 14,039,090 13,250,790 While the total number of policies in force declined year over year, the face amount of insurance coverage in force increased by approximately $800 million. This reflects the Company's changing business mix toward international life sales and a change in emphasis domestically toward larger policies. The international life products typically have larger average face amounts of coverage per policy due to the higher net worth of the individuals purchasing these products. The average face amount of coverage for international life product sales in the first six months of 2005 was approximately $234,000 while the average face amount of coverage for domestic life product sales was roughly $108,000. The domestic life insurance in force is comprised substantially of discontinued policies having lower face amounts of coverage. These policies are lapsing at a rate faster than the larger per policy face amounts currently written are being added to the block of business. Annuities The following table sets forth information regarding the Company's annuity sales activity as measured by single and annualized first year premiums. Similar to life insurance sales, these figures are considered a non-gaap financial measure but are shown in accordance with industry practice and depict the Company's sales productivity. Three Months Ended June 30, Six Months Ended June 30, Equity-indexed annuities and other fixed deferred annuities $ 144, , , ,801 Immediate annuities 8,534 7,458 16,200 22,121 Totals $ 153, , , ,922 Annuity sales for the second quarter of 2005 were 41% lower than the comparable period in Year-to-date sales thus far in 2005 were 43% lower than 2004 sales. Annuity sales in the first half of 2004 represented the tail end of the explosion in fixed annuity sales that began in 2003 when the Company achieved nearly $1.2 billion in sales. Annuity sales in the first half of 2004 closely maintained the pace of 2003 in reaching $533 million. However, the sales pace for the last six months of 2004 reduced to a level of $362 million. Annuity sales in the fourth quarter of 2004 were $159 million. The lower sales level reflects interest rates continuing to hover at historical lows, investors returning to alternative investment vehicles, and the Company managing its targeted levels of risk and statutory capital and surplus. 23

24 The sizable increase in annuity sales volume in 2003 and 2004 required a greater level of asset/liability analysis. The Company has monitored its asset/liability matching within the self-constraints of desired capital levels, given the increased attention rating agencies have placed in this area. Despite the significant increase in new business, the Company s capital level remains substantially above industry averages and regulator targets. The mix of annuity sales in 2004 and 2005 changed from that of With a stronger performance in the equity market, sales of equity-indexed annuity products became more prevalent beginning in 2004 and have continued thus far in Contributing to the increase in sales of these products was the introduction of a new series of equity-indexed annuity products featuring a different indexing mechanism (monthly cap) to complement the existing equity-indexed annuity products which utilize a monthly average annual reset feature. For all equity-indexed products, the Company purchases over the counter options to fully hedge the equity return feature. The options are purchased concurrent with the issuance of the annuity contracts in order to minimize any form of timing risk. All of the index return during the indexing period (if the underlying index increases) is credited to the contract holders electing the equity feature at the beginning of the contract year. The Company does not deliberately mismatch or under hedge for the equity feature of these products. The following table sets forth information regarding annuities in force for each date presented. Annuities In Force as of June 30, ($ in thousands) Equity-indexed annuities Number of policies 25,430 20,720 GAAP annuity reserves $ 1,473,330 1,182,820 Other deferred annuities Number of policies 85,330 86,530 GAAP annuity reserves $ 2,730,710 2,657,980 Immediate annuities Number of policies 12,540 12,510 GAAP annuity reserves $ 248, ,910 Total annuities Number of policies 123, ,760 GAAP annuity reserves $ 4,452,830 4,079,710 24

25 RESULTS OF OPERATIONS The Company's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). In addition, the Company regularly evaluates operating performance using non-gaap financial measures which exclude or segregate derivatives and realized investment gains and losses from operating revenues and earnings. Similar measures are commonly used in the insurance industry in order to assess profitability and results from ongoing operations. The Company believes that the presentation of these non-gaap financial measures enhances the understanding of the Company's results of operations by highlighting the results from ongoing operations and the underlying profitability factors of the Company's business. The Company excludes or segregates derivatives and realized investment gains and losses because such items are often the result of events which may or may not be at the Company's discretion and the fluctuating effects of these items could distort trends in the underlying profitability of the Company's business. Therefore, in the following sections discussing consolidated operations and segment operations appropriate reconciliations have been included to report information management considers useful in enhancing an understanding of the Company's operations to reportable GAAP reflected in the financial statements. Consolidated Operations Revenues: The following details Company revenues. Three Months Ended June 30, Six Months Ended June 30, Traditional life and annuity premiums $ 3,932 3,633 7,413 7,021 Universal life and annuity contract revenues 24,642 22,882 48,590 43,887 Net investment income excluding derivatives 81,966 76, , ,756 Other income 2,319 2,476 4,552 4,607 Operating revenues 112, , , ,271 Derivative gains (losses) (2,478) (186) (16,400) 1,200 Realized gains on investments 7,616 2,013 8,584 3,472 Total revenues $ 117, , , ,943 Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period. These are product lines that the Company has not put as much of an emphasis on relative to interest sensitive products, particularly in its international life insurance operations. Revenues for universal life and annuity products consist of policy charges for the cost of insurance, administration charges, and surrender charges assessed against policyholder account balances. Product sales have remained consistent from 2004 to 2005 with the block of business in force, particularly international universal life products, growing steadily. This contributes to higher revenues in the form of cost of insurance charges which were $15.7 million in the second quarter of 2005 compared to $14.9 million in 2004, respectively. Six month figures were $31.2 million compared to $29.6 million for 2005 and Surrender charges assessed against policyholder account balances upon withdrawal increased to $7.0 million from $6.7 million for the three months ended June 30, 2005 and 2004 and to $13.1 million in the first six months of 2005 versus $11.4 million for the same time period in

26 A detail of net investment income is provided below. Three Months Ended June 30, Six Months Ended June 30, Gross investment income: Debt securities $ 73,443 69, , ,399 Mortgage loans 2,324 3,547 4,966 6,739 Policy loans 1,588 1,593 3,176 3,220 Other investment income 4,956 2,959 6,469 4,435 Total investment income 82,311 77, , ,793 Investment expenses ,063 1,037 Net investment income (excluding derivatives) 81,966 76, , ,756 Derivative gains (losses) (2,478) (186) (16,400) 1,200 Net investment income $ 79,488 76, , ,956 Net investable cash flow is primarily invested in investment grade debt securities, which represent 91% of the total investment income for the six months ended June 30, For the first six months ended June 30, investment income generated from mortgage loans has decreased 26% in 2005 compared to 2004 due to the decline in the mortgage loan portfolio caused by the low interest rate environment over the past several years. Interest rates have fallen below the Company's minimum rate required for mortgage loan funding and the current environment has also enduced pre-payment of loans. Despite the drop in interest rate levels, the Company still generated higher overall net investment earnings, excluding derivatives, due to higher levels of invested assets. Other investment income for the three months ended June 30, 2005, includes $2.3 million relating to a profit distribution received by The Westcap Corporation, a wholly owned subsidiary, from a joint venture investment. Derivative gains and losses fluctuate with the performance of the S&P 500 Composite Stock Price Index ("S&P 500 Index "). Net investment income performance is analyzed excluding derivative income, which is a common practice in the insurance industry, in order to assess underlying profitability and results from ongoing operations. Net investment income performance is summarized as follows: Excluding derivatives: Six Months Ended June 30, (In thousands except percentages) Net investment income $ 158, ,756 Average invested assets, at amortized cost $ 5,101,518 4,556,932 Annual yield on average invested assets 6.22% 6.48% Including derivatives: Net investment income $ 142, ,956 Average invested assets, at amortized cost $ 5,156,932 4,596,341 Annual yield on average invested assets 5.52% 6.48% The yield, excluding derivatives, on average invested assets has declined from 6.48% for the six months ended June 30, 2004 to 6.22% for the first six months ended in This drop in yield is due to the overall interest rate declines in the market which result in the Company obtaining lower yields on new business investments. 26